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The question of how to profit from a housing downturn may have a simpler answer than you expect.
Based on the stock market impact of the Home Capital situation, there's evidence to suggest that bonds might just do it. Home Capital is the alternative mortgage lender that has been targeted by securities regulators over allegations of not properly disclosing flaws in its mortgage underwriting process to investors. The company's share price has plunged, and other players in the mortgage business have been affected as well. For instance, shares of the Big Six banks are down sharply over the past five days.
Meanwhile, bonds have quietly been doing well. The iShares Canadian Universe Bond Index ETF (XBB), a proxy for the broad Canadian bond market, had a one-month gain of 1.4 per cent to May 2, compared to 0.5 per cent for the S&P/TSX composite index.
Bonds are mainly reacting to a sense that the inflation risks seen just a few months ago are not a concern for now. Profiting from economic disappointments is one of the big reasons to own bonds. So what has this to do with housing? If Canada's housing market tanks, it's going to hurt the economy. There are estimates that the broad real estate industry accounted for about 12 per cent of the country's economic output last year.
Shorting the shares of banks and companies in the real estate business is one way to profit from a housing downturn. But maintaining exposure to bonds is easier and lower risk. Diversified bond exchange traded funds and mutual funds can help in this regard because they expose you in a measured way to longer-term bonds and corporate bonds.
Both bond market sectors have been particularly strong lately, but you wouldn't want to bet too heavily on them. Bonds maturing in more than five years would be hard hit if the economic outlook suddenly brightened, while corporate bonds could be vulnerable if the economy were to take a decisive turn for the worse.
As recently as a few months ago, bonds were on the outs with some investors because of concerns about the return of inflation. Doubts about the economy have perked up interest in bonds and you can expect more of this if the housing market falls